For many, 2022 couldn’t end fast enough. But will 2023 be any better? Depends who you talk to. Macroeconomic conditions, geopolitical cross-border conflict and a host of other factors have resulted in a cloudy outlook. To get a clearer view on what dealmakers expect in the year ahead, Mergers & Acquisitions tapped some of the industry’s top bankers, lawyers, lenders, advisors, placement agents and business development firms to share their insights on what is likely to come. Let’s go ‘round the horn and hear what they have to say.
What is your outlook for the economy in 2023?
“My outlook for the general economy in 2023 is unfortunately one of uncertainty,” says Brian Forman, partner at law firm Morrison Cohen. “Right now, there are several very significant global macro factors at play, any of which could individually impact the global economy adversely. These factors include the war in Ukraine, global inflation and rising interest rates, and a potential energy crisis over the winter. The fact that individuals are already feeling like their dollars (or other currencies) aren’t buying enough and may have materially increased energy costs could certainly result in depressed consumer spending, and consequently, poor performance for equities.
“On the other hand, depressed prices always result in opportunity, and I’m hopeful that as some of these factors start to resolve, there will be an appetite to raise and deploy capital quickly,” Forman adds. “The war in Ukraine will not last forever, and the Fed will not keep raising interest rates to a point that the collateral damage becomes worse than the problems the rate increases are attempting to solve. When the time is right, I believe that fund managers and allocators will act swiftly to capture the ensuing upside, and this will have positive effects on the economy in general.”
Dwayne Hyzak, CEO of Main Street Capital, echoed Forman’s sentiments. “I expect the economy to take additional steps back during the first half of 2023,” Hyzak says. “However, I do believe that the U.S. economy will continue to be resilient and will significantly outperform the rest of the global economy. Once the Fed starts slowing its interest rate activities and eventually reverses some of its actions, the economy should see significant improvement beginning in the third quarter and continuing in the fourth quarter and 2024.”
Gary Hoover, vice president of TBM Consulting Group, thinks the Fed’s actions will adversely affect company operations. “Rate increases will blunt the impact of inflation but not before companies are left with higher labor and material costs that impact their overall performance. The probability of a soft landing is quickly decreasing.”
Bhavan Suri, managing director of technology at William Blair quantified his forecast. “I expect U.S. GDP to grow roughly one percent in 2023.”
What is your outlook for PE fundraising in 2023?
“PE fundraising will remain slow through all of 2023,” says Fraser Janse van Rensburg, managing partner at Asante Capital, a New York-based placement agent. “But once public markets have completed their bottoming out, the sequel will then be the resuming of M&A activity gradually. This will result in greater liquidity for LPs and likely a lower number of GPs in the market because they will have been slower deploying their funds in 2022 and 2023. Thus, fundraising will start to recover towards the end of 2023 and into 2024.”
What is your outlook for M&A dealflow in 2023?
“There are a lot of mixed data points on the M&A environment,” says Jason Stack, head of Mergers & Acquisitions, Stifel. “We had three strong quarters at Stifel, somewhat bucking the industry trend, but there is no doubt overall deal flow slowed after Labor Day (in 2022) and things seem choppier now than last year at this time. Whether we hit the technical definition of a recession or not doesn’t really matter, as a slowing economy and higher interest rates are headwinds on projections and valuations. There is still a lot of debt that has to get syndicated and worked through the system. Once that happens (and it will happen), and sellers reset their expectations of value, there is still a lot of money on the sidelines that can be put to work.”
Stack says most M&A transactions take 4 to 5 months from “go,” “so we should have more clarity by the spring. The U.S. currently feels more robust than Europe, as some of the macro trends are worse overseas,” he says.
Randy Schwimmer, co-head of Senior Lending, Churchill Asset Management sees a dip and a bounceback. “In parallel to economic conditions we expect deal flow will slow through mid-year, then begin to build up momentum through the second half,” he says. “Overall we think total volume will be slightly down from 2022, but positioned for another strong year in 2024.”
From William Blair’s Suri: “I expect M&A deal flow to pick up in 2023 as the inflationary environment stabilizes. I expect it to be above that of 2022, but still below 2021,” he says.
What sector(s) do you think will be the most active in M&A? Why is that?
“I expect technology to be the most active sector in M&A as valuations have come down,” Suri says. “While public valuations have declined dramatically, private valuations are still coming down. I believe that as private valuations tend to be more in line with public valuations and as interest rates peak (coupled with inflationary concern abating somewhat), both sponsors and strategic buyers will have more confidence and we will witness a commensurate pickup in M&A activity.
“Further, as the economy starts to show signs of recovery in the back half of 2023, secular tailwinds in the software space will lead to more confidence in demand, giving strategics more confidence in acquiring businesses.”
Says Schwimmer: “Defensive sectors will do well next year; particularly technology, business services, healthcare, logistics, and specialized distribution. These are all areas that have seen tailwinds during Covid and continue to benefit from the dynamics related to current consumer and commercial spending.”
Choose a sector you are most familiar with and provide your view on what we should expect in the year ahead.
“In my opinion, we should see continued growth in the private lending industry despite an expected slowdown in new investment activity from private equity firms due to the higher interest rate environment,” says Main Street Capital’s Hyzak. “I expect this growth will come from the continued lack of activity on the part of traditional lenders, which I presume will be under increased pressure from regulators causing them to further reduce their participation in the market. This, combined with the benefits this asset class provides to investors in a rising interest rate environment, should allow the private lending industry to continue to raise capital and continue the growth we’ve seen in its relative share of the lending markets.”
Morrison Cohen’s Forman says, “I believe that growth equity strategies focused on American companies will do well in the coming year. Large multinational companies may experience difficulties in non-U.S. markets, particularly Europe, where consumers will be stretched because of energy costs and the dollar will be expensive for them. Americans, on the other hand, will benefit from a stronger dollar and will not, I hope, have the same increased energy costs as those in Europe that typically rely on Russian oil. Smaller companies that do most of their business in the United States should benefit from these conditions.”
From TBM Consulting’s Hoover: “The business products sector will continue to grow. However, companies in this sector will be challenged with accelerating wage inflation above the recent norm of 3.6 percent. At the same time, job openings will remain high. Despite a cooling in the overall job market, this sector will struggle to attract employees to their payrolls as the ratio of job openings to unemployed will remain above a 2-to-1 level. This means that profitable growth will come only to those who can more effectively manage their recruiting, on-boarding, and retention. Since this sector will have a net inflow of jobs, the ‘winners’ will be those who can attract labor from outside manufacturing. Their success will rely on how adaptive they are to recruit a new generation to manufacturing and how they apply best practices regarding people and skill development.”
“Industrials,” Asante’s van Rensburg cites. “Given the amount of pressure around supply chain issues, this is an area that has been under-invested over the last few years relative to technology and healthcare. In addition, we have medium-to longer-term labor shortages in the U.S., which also require investment in manufacturing and industrials to bridge a gap, so I would expect this area to be a significant growth sector for PE investment over the next year.”
Schwimmer delves into engineering services / consulting, which will have “tremendous tailwinds” that play on the aging of American infrastructure where their services are needed. “This sector also got a big boost from 2022’s passage of the infrastructure law, as well as Build Back America, which will result in over $1 trillion in aggregate spending in the coming years.
“Consulting companies are a small part of the overall project costs, enjoy favorable contract pricing and throw off tremendous amounts of free cash flow due to their high margins and lack of capex and working capital,” he says. It’s also an industry ripe for consolidation as it’s very fragmented and has a big base of privately owned businesses.”
Supply chain problems, rising interest rates, inflation – what are your other macro concerns out there?
“The biggest concern that we’ve seen across our portfolio is the lack of consistent availability of productive labor,” Hyzak says. “This has been a major concern since the beginning of the Covid-19 recovery and continues to be an issue today. While I anticipate seeing improvements in supply chain issues and presume that the Fed will eventually provide some reversal of its interest rate policies, I unfortunately expect labor to be an ongoing issue for the foreseeable future without any clear solutions. As a result, we view automation and other solutions that can reduce dependency on labor as critical to future success.”
Stifel’s Stack believes, “the biggest macro concern is the state of the debt market, linked to and followed by the interest rate environment. The deals that are happening are being over equitized, and I’m not sure this continues indefinitely. The conflict in Ukraine reminded the complacent that it is a big world, and geopolitical shocks happen quickly. Still, there are technical reasons for M&A (like sponsor fund life and dry powder) and strategic reasons regarding innovation, so dealmaking will occur.
“At the very large end of the deal spectrum, strategic transactions are getting a hard look by regulators, particularly in technology,” he says. “While we have not seen excess anti-trust oversight hold up many deals, there is certainly that potential going into the second half of this U.S. administration.”
Hoover says, “for publicly traded companies, cash becomes king again. Manufacturers will be forced to deal money that is tied up with slow moving FG (finished goods) inventory. This challenge is a perfect storm for some as the trifecta of the wrong inventory, high warehouse costs, and low(er) fill rates will be an achilles’ heel for some.
“The ‘reindustrialization’ of the U.S. will be slowed by 2 main items –limited legacy manufacturing skills (i.e. tool and die), and the application of best practices to drive the productivity necessary to meet rising demand,” he says.